It is becoming more and more apparent that today’s breed of politicians is good at only one thing, getting elected.

As folks that have never run a business, never had to tell an employee to clean off his desk or risk any of their own money, our lawmakers should quit pretending like they know what they are doing and let the hard stuff up to the professionals.

Let ‘em outsource the legislation, I say.

Don’t get me wrong, I love my home state of Pennsylvania, but it is run by a gang of numbskulls. By mid-November they have run out of important things to do and are now searching for ways to keep busy.

The state’s auditor general, Jack Wagner, has decided he no longer wants school districts or local municipalities to have the right to hedge their books.

He calls the notion of entering swaps, “…gambling with public money.”

The so-called financial expert backs up his statement with the fact that a local school district had to spend $12 million in “excessive fees and other charges” to unravel swap contracts it had with Morgan Stanley and JP Morgan.

Wagner failed to mention the many, many times the same contracts saved school districts millions of dollars.

If you’re not familiar with the world of swaps, it is a pretty simple concept that allows you to trade something like variable interest rates for fixed rates. Or, in the case of my graduate finance tests, orange juice futures for pork belly futures.

Ask any finance professional worth his salt and he will tell you he’ll take a fixed interest rate over a variable rate any day. A fixed rate is predictable and can be planned for. A variable rate, on the other hand, can do just about anything.

But when school districts or local municipalities offer bonds, they often have to issue them with variable rates, especially when rates are low.

To protect themselves in case interest rates make a drastic turn in the wrong direction, they call in swap dealers like Morgan Stanley or JP Morgan. With a few strokes of a pen, they can lock in a fixed rate.

Unfortunately, as has been the case across the world, swap contracts that made sense in an environment with climbing interest rates no longer make sense now that investors have access to darn-near-free money.

The schools and towns that were acting responsibly by entering basic swaps are now forced to make larger payouts because their hedges went the wrong way.

And what’s a better way for a wannabe politician to get some votes? Make it look like he’s saving poor, old taxpayers from evil Wall Street financiers.

Idiots.

It is this kind of action that forces CFOs to enter the world of creative accounting. Outside of the commodities industry, I dare you to dig through any company’s 10-K and find the word hedge, swap or derivative.

You’ll be hard-pressed to find it, yet any big firm is most certainly using swaps for protection.

But don’t tell their shareholders. If just one contract goes against them, shareholders tend to revolt, telling executives to stop “gambling” with their money.

Knowing that swaps, futures and option contracts are fantastic way to create predictability and price limits, CFOs continue to enter agreements. They simply call them something else.

Ever seen that line on the balance sheet that says “other”?

That’s your swap.

If a politician, elected or appointed, thinks forcing schools and municipalities out of swap contracts will save taxpayers any money, they are either ignorant fools or lying to you.

*** Speaking of ignorant, Alaska’s Department of Revenue is ready to make a blunder of its own. The organization has an unfunded pension balance of $7.5 billion, a common problem these days.

What’s the 49th state’s solution? It wants to issue a $2 billion bond and invest the proceeds in the equities market. If things go its way and the state earns the market average of 8% annual gains on its equities, it could rake in an extra $40 million annually.

But talk about a gamble.

Right now, the state’s bonds are selling with rates just above 6%. But the department says it won’t consider a bond issue unless the rates are below 5.5%. I sure hope not.

Imagine if you or I walked into a bank these days and said give me ten grand. I’ll pay you back with my stock-market gains.

Unless you got out of a $100,000 car and live in a $2 million mansion, you’d be laughed out of the joint.

Now, it’s easy to argue Alaska has more than enough collateral to back up the bonds. I mean it’s not going bankrupt anytime soon. But the chances of a loss on this “intrastate carry trade” are far too high.

Trying to time this top-heavy market is nearly impossible, especially when it will take nearly two months to get the bond sale lined up.

How’s this for the ultimate proof this is a horrific idea? If the state had made the move lawmakers first approved it just months before last fall’s market collapse, it would have lost hundreds of millions of dollars and would have remained on the hook for a couple of billion bucks.

With investing logic like this, it’s no wonder tax rates are soaring across the country. When it comes to investing, our leaders are clueless.

I’d rather let Madoff invest my money. At least he’d have fun with it.

The momentum behind China’s economy is staggering.

“China is increasingly becoming a responsible citizen in the global community,” economist Allen Sinai of Decision Economics told The Associated Press. “No longer lawless, no longer difficult to deal with, much more responsible. It is now a powerhouse among economies and finance. And it’s a rich country.”

In just the past few weeks, two of the world’s key global institutions – the World Bank and the Organization for Economic Cooperation and Development (OECD) – and a large swath of investment banks raised their 2009 and 2010 growth estimates for China’s economy.

The OECD said it now expects China’s economy to grow by 7.7% this year and the World Bank boosted its projection to 7.2% growth.  GDP will expand by 9.3% in 2010, according to OECD estimates.

BNP Paribas SA (OTC: BNPQY), Barclays Capital, Goldman Sachs Group Inc. (NYSE: GS), JPMorgan Chase & Co. (NYSE: JPM), UBS AG (NYSE:UBS), Morgan Stanley (MS), Standard Chartered Bank, and RBC Capital Markets all raised their forecasts for China’s economy as well.

So far, BNP Paribas SA is the most bullish on China’s prospective growth, as it boosted its prediction to 8.2% this year. That would top Beijing’s 8% target.  Barclays Capital, Goldman Sachs, and JPMorgan all raised their 2009 forecasts to 7.8% growth.

“The strong acceleration in underlying economic activity is now unmistakable,” Goldman Sachs economist Yu Song told TIME magazine.

China’s Homegrown Growth

China’s $585 billion (4 trillion yuan) stimulus package gave the economy a big kick in the first half of the year, spurring bank lending and driving fixed asset investment. It even stimulated the oft-maligned Chinese consumer, boosting domestic demand while the market for exports remained dormant.

Chinese banks lent about $1.08 trillion (7.37 trillion yuan) in the first half of the year, nearly double the total loans extended throughout all of 2008.  And even though the economy is clearly on the road to recovery, it’s not likely lending will let up for the rest of the year.

BNP Paribas chief economist Chen Xingdong told Bloomberg thathe expects new loans will reach 9.5 trillion yuan by the end of 2009.

“The growth recovery has been even stronger than our anticipation,” Chen said.  “Strong fixed-asset investment growth and retail sales have started to generate real demand for industrial production.”

Fixed-asset investment rose 33.5% in the first half year to $1.34 trillion (9.132 trillion yuan), according to the National Bureau of Statistics (NBS). Investment in infrastructure rose 57.4% year-over-year, with spending on railways up 126.5% and highway spending up 54.7%. Property sales were up 53% in the first six months from a year earlier.

Of course, fixed-asset investment has been consistently strong in China for the past decade. The real turnaround in the past six months has been that the frugal Chinese consumer has begun to spend more liberally.

China’s retail sales in the first half of the year rose 15% to $859.6 billion (5.87 trillion yuan).  Retail sales in June also rose 15% from May, said NBS spokesman Li Xiaochao.

“There were two highlights in promoting domestic demand: commercial apartments sales rose by 31.7% in the first half year from the same period last year; automobile sales expanded by 17.7% year on year,” Li said.

Auto sales reached 6.1 million vehicles in the first six months, helping China to supplant the United States as the world’s largest automarket. Sales could easily surpass 12 million this year.

“The rebound has been driven by the domestic economy,” Jing Ulrich JPMorgan Chase & Co.’s Chinese equities strategist told Fortunemagazine. “The consumer proved resilient – and the government acted as a catalyst.”

“China can still achieve 8% growth,” she said. “Everything is happening very fast there.”

The One Potential Hurdle for China’s Economy

There’s no question that China’s stimulus package has been an unequivocal success. In fact, the only problem may be that it is working a bit too well.

In the United States concern about inflation prompted Federal Reserve Chairman Ben S. Bernanke to outline an “exit strategy” for the withdrawal of liquidity from the financial system. Similarly, China’s biggest challenge going forward will be clamping down on lending to keep potentially hazardous bubbles from growing in its economy.

Inflation is a particular concern, as rising commodity prices have crept into imports.

“Commodity markets around the world have bottomed and are rebounding, raising imported inflation pressures,” the People’s Bank of China (BOC) said in a report analyzing second-quarter economic trends, issued by its Financial Survey and Statistics Department. “At the same time, domestic demand continues to rebound, liquidity remains flush and inflation expectations are surfacing.”

However, as in the United States, policymakers in Beijing have said they will remain committed to “proactive fiscal policy” until it is certain a recovery is underway. In fact, some analysts don’t expect to see a significant change in policy until November, when leaders and regulators meet for their annual conference on the economy.

“We must see that the economic recovery is not on a solid foundation, and the negative impacts from the international crisis have not eased,” said Chinese Premier Wen Jiabao. “An improvement in the economy does not mean the difficult period is over.”

Indeed, stimulus must be maintained until China’s all-important export sector has recovered. And while Chinese exports climbed 7.5% from May to June, they were still down 21.4% from a year ago.

Of course that doesn’t mean Beijing will just sit back and wait for lending to reach excessive levels.

“China has achieved impressive results in reviving economic activities,” Gao Shanwen, chief economist with Essence Securities, told Reuters. “The basic tone of the appropriately loose monetary policy is unlikely to change, but there will be fine-tuning.”

The BOC has traditionally used a quota system to control lending, telling banks not to exceed specific ceilings. It may continue to do so if the central bank does not see a sufficient drop in lending. It may also choose to provide banks with a less stringent lending guidance, or range, rather than an outright ceiling.

“The banks are highly responsive to government policy,” Ha Jiming, of China International Capital Corp. Ltd. (CICC), the nation’s largest investment bank, told The Financial Times.

Punitive bill issuances are another tool in the central bank’s toolkit. In September, the BOC will require banks to buy $15 billion (100 billion yuan) in special bills. The bills will be issued at punitively low interest rates and reduce the amount of money banks have on hand to lend out.

Regardless of what methods it chooses, the BOC is clearly ready to act. But it won’t jeopardize a recovery in a preemptive assault on inflation.

The central bank “will unswervingly continue to apply appropriately loose monetary policy and consolidate the economic recovery momentum,” said Su Ning, vice governor of the People’s Bank of China.

Source: With Its Economy Ignited by Stimulus Spending, China Is Leading the Global Recovery

Good day… Chuck got an early start on a two week hiatus from the desk, so you will be stuck with me writing the Pfennig for the next two weeks. But don’t worry, you will still get a small dose of Chuck over the next week as he typically emails me his thoughts while on the road (I call it Pfennig Pfodder). Risk aversion dominated the currency markets overnight, as terrorists set off two separate explosions in Jakarta and investors moved money back into the ’safe havens’ of the US$ and Japanese yen.

Chuck wrote about this move yesterday, believing the bad news regarding CIT would probably cause a risk reversal. But the US stock market shook off the CIT news and rallied higher after a big earnings report by JP Morgan and a somewhat positive statement by Nouriel Roubini. Roubini, the New York University economist who is credited with predicting the financial crisis, said in a speech yesterday that the US economy might be close to the bottom. The stock jockeys took this statement along with the positive earnings reports and ran stocks up. But Roubini later tried to caution these bulls against reading too much into his statement, and reminded everyone that he has not changed his thoughts on a US recovery: “I continue to see a shallow, below par and below trend recovery.”

Those looking for a quick v shaped recovery will be disappointed, as we continue to believe the recovery here in the US will be more of an L shape as our economy struggles to recover. After all, who is going to propel the US economy to recovery? In past recessions, we have been able to depend on the US consumer to pull us back out. But the poor consumer is now facing the highest unemployment rate post WWII combined with falling home prices and much stricter lending policies. And with the dire fiscal position of most states matching that of the federal government, the tax burden placed on almost all taxpayers will likely be rising, chewing up more of consumers disposable income. We are no longer be able to rely on US consumers to ‘borrow and spend’ our way to GDP growth (which is actually a good thing!!). Consumers are tightening their belts, and saving a larger percentage of their income; good news for the consumers, but bad news for the economy.

The administration has tried to take over where the US consumer left off by borrowing record amounts of money and injecting it into the economy through stimulus packages. But recent data bring into question whether or not this stimulus is having the desired effect, and many are now questioning whether any fiscal measures can pull the economy out of recession. With the credit markets still tight, and the negative outlook for consumer demand, no amount of government intervention seems able to stop the decline in jobs and quickly pull the US out of this recession/depression. The reason is that the ‘multiplier effect’ of the stimulus money is too low. Typically when the government injects funds into the economy, the effect of each dollar they spend is multiplied several times over as it moves through the lending / spending cycles. It works like this: $1,000,000 given to a bank by the Fed is lent out to consumers and business who then spend the funds on goods and services. The companies who sell the goods and services place a majority of these funds back into the bank who then turn around and lend them back out, starting the cycle all over again. But recently neither the banks or the consumers are acting ‘normal’. Banks who have received stimulus funds are using them to shore up balance sheets and keeping them in reserves. Consumers who have received stimulus funds, or are strong enough to qualify for loans have been doing the same thing; using the funds to pay down debts and saving a larger percentage. So the multiplier effect of each dollar injected by the administration has been much smaller than in years past. While some in the administration are calling for another stimulus package, others are now realizing the impact of government stimulus will continue to be decreased by the low multiplier. The government should probably just let the recession take its course, and avoid adding more debt to our already over burdened tax payers.

But ‘big government’ is back, and the current administration obviously feels it is their job to make government even bigger. Chuck had this to say about this weeks earlier announcement of a new government run health care program:

“The Big Debate right now is a National Health Care program… I’ll come right out front and center and say that I’m not for it, which shouldn’t surprise anyone that’s been reading this letter very long. But there’s someone else who should be more important a figure against this than I think the media is reporting…

I’m talking about Douglas Elmendorf, the Director of the Congressional Budget Office who, under questioning by members of the Senate Budget Committee, had this to say…
“Instead of saving the federal government from fiscal catastrophe, the health reform measures being drafted by congressional Democrats would worsen an already bleak budget outlook, increasing deficit projections and driving the nation more deeply into debt.”

He went on to say… That “bills crafted by House leaders and the Senate Health Committee do NOT propose the sort of fundamental changes that would be necessary to reduce the trajectory of federal health spending by a significant amount.”

But… I doubt they listen to him… For when it comes to spending and driving up the deficits.. They haven’t listened to former CBO director, Alice Rivlin… And they haven’t listened to former Comptroller General, David Walker… Why the current CBO director now?”

Data released yesterday showed the number of Americans filing claims for unemployment benefits fell last week to the lowest level since January. But like last week, these jobless claims were skewed by the Labor Department’s ‘adjustments’. As I explained last week, the automakers typically lay off workers during July, so the BLS adds back thousands of jobs in order to offset these seasonal layoffs. But this year, the auto plants laid off these workers months ago, so the seasonal adjustments are adjusting away actual job layoffs, not just temporary automobile layoffs. These distortions will likely continue for the next few weeks, with the weekly numbers climbing back over 600,000 in August when the seasonal adjustments end.

The TIC flows were also released yesterday and showed International demand for long term US financial assets weakened in May. Investors sold the most Treasury notes and bonds in six months, with the net Long-term TIC flows dropping almost $20 billion. The ‘experts’ had predicted a rise of $16.5 billion in purchases. But as investors dumped long term Treasuries, purchases of US stocks in May were the strongest since January of 2008. So the impact of these flows were minimal on the value of the US$. The administration has to be worrying about the direction of the TIC flows, as it continues to bring record amounts of Treasuries to the markets. If investors shy away from the new debt, interest rates will be driven higher putting further pressure on our ’stealth recovery’.

After reviewing the numbers, I spotted another item which should be cause for concern. The report showed foreign governments were moving from the longer term maturities of Treasury notes and bonds into shorter term bills which have a maturity of less than one year. Foreign governments continue to be worried about the future ability of the US to maintain our record deficits. The Chinese economy continues to grow, and is propelling them to a much more important status among global leaders. Chinese Premier Wen Jiabo continues to express concerns regarding his country’s US Treasury holdings, and officials in Japan, the second largest investor, have also begun to express concern. The administration is calling in the big guns to try and assuage China’s concerns. Federal Reserve Chairman Ben S. Bernanke will brief Chinese officials at a summit this month about how the US plans to keep inflation in check over the next few years. The summit is the first high-level gathering of its kind since President Obama took office.

China reported yesterday that their economy grew 7.9% in the 2nd QTR, which was greater than the 7.7% forecast by economists, and the 6.1% that was booked in the 1st QTR. This was the first acceleration in growth in more than two years, and comes on the heels of a $585 billion stimulus package which was targeted at increasing infrastructure and getting credit flowing again. The positive growth number will likely cause them to start raising rates in 2010 according to a Bloomberg news survey. Economists predict the one-year lending rate will climb over 50 basis points after remaining steady for the rest of the year. China is the only one of the 10 biggest economies that is expanding, and confirms what we have been saying for some time: China will be the engine which propels the global economy out of recession.

Chuck noticed the good numbers out of China before heading out yesterday, and sent me the following:

“This news must be manna from heaven for Australian commodity exporters… As I’ve said for some time now… China’s economic strength strong demand for raw materials, of which Australia is not only geographically positioned to supply China with raw materials, but has the raw materials to supply to China! And demand for Australian raw materials is a proxy for commodities as a whole… And, will underpin the A$!”

If you agree with what Chuck is saying regarding the A$, it may be a good time to buy some more as the AUD$ slid below .80 overnight due to risk aversion. Both the AUD$ and NZD$ fell against the dollar and the yen as investors shifted to safe haven currencies. The New Zealand dollar fell the most in two weeks after Fitch Ratings cut the nation’s long term sovereign credit rating outlook to negative. Fitch said the nation’s deficit is large and a “stronger fiscal adjustment than currently planned” may be needed. First, I think everyone should treat anything coming out of the rating agencies with caution. But I agree that the nation’s deficit is too large, but the news coming out of China should go a long way toward pushing these commodity exporting countries back into the black. As Chuck says above, as China expands the commodity currencies should stay well bid.

Before I head to the big finish, Chuck wanted me to make this announcement to all the Pfennig readers….

After 2 long years of looking for the next MarketSafe CD to issue, I decided to put together the countries that have been in the news lately. So… Introducing: The EverBank MarketSafe BRICK CD! This will be a 3-year CD that will have FDIC protection, 100% Principal Protection, and 100% of the upside of the combined values of the currencies from Brazil, Russia, India and China! If the combined values of these 4 currencies should go down in 3 years, you’ll get your principal back!

To invest in this new MarketSafe CD, you need to either go to: www.everbank.com where after reviewing the offering you will be able to apply for the CD right on line, or by calling the trading desk @ 1-800-926-4922 for the details.

Currencies today 7/17/09: A$ .8000, kiwi .6444, C$ .8945, euro 1.4100, sterling 1.6291, Swiss .9276, rand 8.102, krone 6.3926, SEK 7.8203, forint 194.08, zloty 3.0682, koruna 18.3992, yen 93.83, sing 1.4504, HKD 7.7501, INR 48.68, China 6.8316, pesos 13.58, BRL 1.9318, dollar index 79.49, Oil $61.93, 10-year 3.56%, Silver $13.19, and Gold… $934.45

That’s it for today… The EverBank kickball team pulled out another victory last night in a tightly contested match. Happily, none of our players were injured, but a player on the opposing team did a faceplant which still has everyone on the desk laughing. The weather here in St. Louis has turned fall like, and we are supposed to have record lows over the weekend. Should be perfect for a triathlon I am competing in Sunday morning. Hope everyone has a Fantastic Friday and a Wonderful Weekend!!

Source: Risk Aversion Returns

Good day… And a Marvelous Monday to you! A Home Run Derby Monday to boot! I have no Idea what’s going on this morning, as I just woke up, and it’s very late in the morning! I was very careful to set my alarm last night, and I’ve never been one of those people that hit the snooze button when it goes off, but here I am, waking up late… UGH!

So… I’m writing from home, and then I’ll shoot in to work… We’re short handed this week, so, I’m sure everyone will be arriving to the office, not see my car, and be a little ticked… So, I’ve got a surprise for them, something they’ve never seen… Me come in late!

Well… It looks like Risk is under pressure once again… And the only thing I can see that’s causing this Risk Aversion, is the Corporate Earnings Season… For instance we get 4 banks reporting this week, Goldman (yes, remember they’re a bank holding company now… They ex-chief, and ex-Treasury Sec. Paulson, made sure that the change was made so that Goldman would qualify for TARP last year!) We also have JP Morgan, Bank of America, and Citi…

Data wise, there are a few top shelf reports out this week, and the thought of them showing more dandelions instead of green shoots, is probably wearing heavily on the risk assets this morning too.

So… The euro is sitting just below 1.40 this morning at 1.3985, so no real harm being done at this time, but still the bias is to sell the risk assets like currencies and commodities as we start the week.

You know, I’ve harped about this for so long now, that I sound like a broken record, OOOPS! For the younger crowd that would be a scratched CD! What I’m talking about is the fact that the risk assets like currencies and commodities being thrown into the same barrel has stocks… And how I was just wishin’ and hopin’ and thinkin’ and prayin’ that we would return to the fundamentals of these asset classes not having anything in common with the stocks! I just knew… No wait, I can’t say that… I just knew, not that I know anything on the inside, that is… That stocks were going to be under pressure from the Corporate earnings season, and with the “link” still in place… That wouldn’t be good for currencies and commodities… Let’s hope I’m wrong!

The one piece of data we get today is the Budget Statement… Last month, the Budget Statement printed an awful deficit of -$189.7 Billion (May)… Historically, June prints at a surplus… But Historically, so did April, and April was no where near a surplus this year! Year-to-date receipts for the Gov’t are down 18%, and Year-to-date outlays are up 19%… That doesn’t bode well for “history to come into play here”…

Last week, on Thursday, reported Friday in the Pfennig (thanks Chris!) was the Weekly Initial Jobless Claims, which printed the lowest level for this data series in more than 6 months, at less than 600K! But still, the number is still staggering, and one of the reasons that Commercial construction in the U.S. is set to decline 16% this year, followed by a 12% fall in 2010. No jobs… no need to build offices for the “ghost jobs’ that the BLS adds each month, because… THEY DON’T EXIST!

No need to get me started on the BLS (Bureau of Labor Statistics) this morning… I have to be clear and concise to get this out the door and me off to work!

Well… With the risk aversion back on the table… The two main beneficiaries remain to be Japanese yen and the U.S. dollar… Swiss francs are on the “kids table” but still a part of the beneficiary crowd…

The High Yielders like Aussie, kiwi, and South Africa get taken to the woodshed, when Risk Aversion comes to town… The Brazilian real is seeing a bias to sell, but for the most part has hung in there… Of course I remember saying that exact line early last fall, only to watch the real play catch up, until the turn-around in March of this year. So… I guess, what I’m saying is be careful!

So! Did you hear that Russian President Medvedev, showed off the “new world currency coin” at the G-8 meeting last week? He said.. “We are discussing both the use of other national currencies, including the ruble, as a reserve currency, as well as supranational currencies. So… Here it is! This is a symbol of our unity and our desire to settle such issues jointly.”

He then pulled a new coin out of his pocket and displayed to the attendees… Now… Don’t get all tied up and twisted over this at this point. This was simply a “symbolic” move, there aren’t mints all over the world rushing to get these coins minted and out the door… But, if you get the “symbolic” part, then you understand what Medvedev was attempting to do here… He was simply showing the G-8 attendees that if they really thought about it, they could see the need to move from a dollar reserve system, and to help them visualize it, he had a coin to pass around!

I can’t believe that right now, with the whispering campaign to get an alternative reserve currency, that the dollar isn’t getting sold, as I like to say, like funnel cakes at a State Fair! I guess the whispering will have to get louder, for this to make any real waves….

You know, I’m not for this “global currency”… I just wanted to make that clear! I’m not for removing the dollar as the reserve currency, for I know all of the “perks” that go along with it being the reserve currency! I’m just here to report the facts, and give my opinion / market commentary on how I think it will affect things…

I do believe, however, that given our deficit spending, and every growing to the moon National Debt, that the dollar deserves getting whacked, it’s how things are done! Treasuries will get their comeuppance too one day… You can’t just keep printing and printing and thinking that “buyers” will be there at the auction every time you print more… It’s not going to happen that way… At least in my thoughts it won’t!

OK… Time to go to the Big Finish… I know, I know, little shorter than usual this morning… But Hey! It was still chock-full-o-news!

Currencies today 7/13/09: A$ .7750, kiwi .6225, C$ .8605, euro 1.3980, sterling 1.61, Swiss .9240, rand 8.2930, krone 6.4830, SEK 7.9025, forint 198.10, zloty 3.1475, koruna 18.62, yen 92.10, sing 1.4650, HKD 7.75, INR 49.08, China 6.8328, pesos 13.71, BRL 1.9965, dollar index 80.16, Oil $59.96, 10-yr 3.30%, Silver $12.50, and Gold… $912.70

That’s it for today… Went to the Futures Game yesterday, to sit through a 4-hour rain delay… UGH! Let’s hope the rain stays away for the next two days! Home Run Derby tonight, All-Star Game tomorrow night. The family is all going to the Fan-Fest today, while I’m at work… Hey! Somebody has to work! HAHAHAHAHA! My beloved Cardinals went into the All-Star Game break on a good note, winning 6 of 10 on the road trip to end the 1st half of the season… This will be a very busy week for me, lots of writing to get done, and all the All-Star festivities… I go to my new oncologist this afternoon for the results of my scans on Friday, so all that and doctors stuff on top! UGH! Oh well, next Monday I head to Vancouver for the Agora Financial Wealth Symposium, their 10th year anniversary of the conference! And then I head off to vacation! So… Busy, busy, busy… Time to hit send, Hope your Monday is absolutely Marvelous I tell you!

Source:  Back To Risk Aversion!

In our eyes, there has always been something strangely stage managed about this rally, which sent the badly wounded S&P 500 zooming up about 31% from its March 6 lows. First, the ‘leaked’ memos… then the earnings report press releases… then the bogus earnings reports themselves – filled with once-off items, FASB accounting hocus-pocus and missing months.

But the massive increase in program trading (computer trading of large baskets of stocks) by Goldman adds an even stranger dimension. The bank has fed the rally with a massive increase in its principal program trading at a time when other quant funds and program traders have been quickly deleveraging. One billion shares principal traded is becoming the weekly norm for Goldman.

There’s a neat quid pro quo here, if you care to look for it. The government bails out AIG using taxpayers’ money. The idea supposedly being to provide enough liquidity to AIG to allow it to make credit-default-swap settlements to counterparties at significant haircuts to avoid “systematic risk.” But what happened? These trades were settled at 100% – handing massive profits to counterparty banks.

The bank in receipt of the biggest AIG settlement, Goldman Sachs, then uses these funds (or part thereof) to feed the rally in stocks via its massive principal program trading operation, thus relieving pressure on the Obama administration as it completes its significant 100 days in office milestone.

Look close enough and what you see if a massive taxpayer-financed rally orchestrated by the banks and their government sponsors. First, the AIG conduit: the counterparty CDS unwinds were taxpayer financed. Ditto the PPIP, which proposes using tax dollars as leverage for private funds who want to buy toxic assets from banks. The banks have also been raising money via government-backed debt issuances – something very few mainstream investors understand or even know about.

Luckily, there are alternatives to trusting your luck in this kind of market. For instance, Money Morning’s Geiger Index trading program has maintained a 100% success rate this year.

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It can look deep inside any investment – stocks, currencies, ETFs, bonds – for any given time and pinpoint its price with 95% accuracy.  To find out exactly how it does this, go to this free report.

You see, there’s a bond scandal that was uncovered in Italy, with Italy losing large sums of money, and some major banks like Deutsche Bank and UBS are right smack dab in the middle of the investigations. With Deutsche Bank in Euroland, and UBS in Switzerland, there you have the story behind those two currencies taking a beating from the dollar the past two days. There are other banks like JP Morgan Chase reportedly involved, but the majority of the problems resides in Europe… Let me try to explain the problem, as I know it to be from reading the story in the U.K. Telegraph last night.

Investment bankers, many based in London, spotted a major opportunity in the 1990s. Italian cities and regions wanted to borrow money. In order to avoid ballooning debt, the central government required local authorities to put away a percentage of the loan every year in a “sinking fund” so that when it was time to repay the full sum, they would be able to do so.

Investment banks offered to manage the sinking funds. While the funds initially had to be invested in Italian government bonds, the criteria were widened to include other government debt within the European Union. This could include debt from countries seen as more likely to default, such as Greece, as long as it was triple-A rated.

The banks took a fee to manage the sinking funds. They argued to the Italian authorities that as well as saving the money to repay their initial loan, they might also make some money from the investments. Many did when the global economy was booming.

All of the contracts were different. But critics have said some contained a “sting” which was not properly understood by some of the Italian authorities. While the local authorities only earned a return on the money they put aside, the value of their total loan was at risk. The banks could invest all of the money the authority had borrowed through bonds. If everything went well, the bank would pay a return based on the incremental amounts the local authority was putting into the sinking fund, and keep the rest as profit.

If things went badly, it was the local authority which would have to pay for the loss – and then also have to pay off the bond when it became due.

And THAT my friends is the big bugaboo right now… Things have not gone well, and the local Italian authorities (like cities) are left holding the bag, and they have no way of paying this debt! It’s a remake of: The Italian Job!

OK… That was a long explanation, but one that was needed, I believe, to explain this mess… One thing that I did notice in the story is that a Japanese Bank (Nomura) was involved, and this is the first instance of any involvement of a Japanese Bank in any of the mortgage bond meltdown and now this. Could be why the Japanese yen has seen a removal from terra firma the past couple of days.

There’s also the euphoria going on from the Obama Bounce… I’ve explained this a couple of times now in the first few days of 2009, so I won’t go there again, but when the President-elect goes on TV to discuss is “stimulus plan” the “bounce” gets magnified. There’s a lot of euphoria being built up for this plan. My problem is the size that it will end up being once the lawmakers get their hands on it, and begin hanging other spending bills on the plan. That just adds to our National Debt, folks… And that, in a nutshell, is a BIG Problem for me…

The euphoria is spilling over to the risk takers, as I explained yesterday. The Big Winner yesterday was the Brazilian real, which last week had a full 6 figure move higher, followed that yesterday with a full 8 figure move higher! WOW! OK… Before we get too excited about reals, let me point out that this huge rally in the past week, has left reals about at November’s levels. It’s still got a long way to go, to get back to last summer’s levels… But, Shoot Rudy! Why throw cold water on this move? 14 figures higher is better than 14 figures lower!

OK… Have you been following this Madoff stuff? So… I hear that the lawmakers are going to grill the SEC… As if! As if the lawmakers, save for Ron Paul, could have figured out what Madoff was up to if they were the SEC! But, it’s interesting anyway… The thing that ticks me off about the Madoff meltdown is that his people pulled the wool over the SEC’s eyes, even though there had been 8 probes by the SEC in the past 16 years…

Other lawmakers expressed concern about the make up of the SEC and even whether it should exist. Rep. Ron Paul, R-Texas, said he believes Congress should eliminate the agency, which he argued gave investors a false sense of security about Madoff and other problematic investment vehicles. “Investors should be self-reliant,” Paul said.

Did you see the collapse of Auto Sales yesterday? YIKES! Where have all the car sales gone? Long time passing… Shoot Rudy, even Toyota has announced that they will shut down their plants for 11 days in Feb and March… Now, that’s should tell us something… Here’s what the Wall Street Journal printed… “GM posted a 31% drop in U.S. light-vehicle sales for December, while Ford reported a 32% fall. Toyota saw a 37% decline, and Honda saw sales drop 35%, closing out the auto industry’s worst year in more than 15 years.”

Of course one might think that there would be some “real” sales for autos, eh? And not that cheesy “you get what we pay” promotion… I mean something with some real meat to it! Better to sell than to see it rot on a sales lot!

Well… The European Central Bank (ECB) and the Bank of England (BOE) both meet this week to discuss interest rates. There’s some speculation out there that the ECB will cut rates, especially after it was announced this morning that inflation for the Eurozone has fallen to lowest level in 2 years… Of course oil prices are behind that fall in inflation, but still… The ECB has done a marvelous job of providing price stability, even when Oil prices were shooting for the moon… Of course, I’m of the opinion that we’ll see Oil prices shooting higher again, and this is all great right now, but it won’t last.

Inflation for the Eurozone hit 1.6% in December, down from 2.1% the previous month… Now that inflation is back under the ECB’s 2% ceiling target for inflation, we could very well see them cut rates this week… But, I’m going to go out on a limb and say they will be prudent and wait… But then, I don’t know about any smokey back room deals between the Fed and ECB…

The BOE will also meet, and I DO expect them to cut rates this week… The BOE is cut from the same cloth as the Fed, and believes that lower interest rates are the way to a Lender’s heart… I would argue that the way to a lender’s heart is through their stomach… They need to be fed tons and tons of cash, which is another arrow in the Fed’s quiver that they are using… But not the BOE at this time…

Today, in the U.S…. We’ll see Factory Orders for November (pretty long lag, I agree!) which I believe will follow up the previous month’s rotten print of -5.1% with another negative print of -2.3%. We’ll also see Pending Home Sales for Nov. , and later today, we’ll see the color of the last Fed meeting minutes, when they cut rates to .25%… These ought to be good!

The ISM (non-manufacturing) Index, which covers the Servicing Industry, will print too… And I don’t normally give two hoots about the Index, except for the employment component of the report, which is normally where I get my thoughts about where the total Jobs Jamboree will print. There, I just gave away one of my secrets! And you didn’t have to pay a penny for it either! WOW! What a guy! OK, stop it Chuck! Seriously though, I do use the employment component of this report to give me a clue about where the National jobs will print… So, here’s a key to look for!

Currencies today 1/6/09: A$ .7115, kiwi .5870, C$ .8405, euro 1.3350, sterling 1.46, Swiss .89, rand 9.31, krone 7.0420, SEK 7.94, forint 200, zloty 3.04, koruna 19.79, yen 94.10, sing 1.4790, HKD 7.7535, INR 48.69, China 6.8363, pesos 13.35, BRL 2.1820, dollar index 83.81, Oil $49.66, Silver $10.87, and Gold… $841.55

Source: Italian Job

More from The Daily Reckoning:

The late November rally in gold prices wasn’t quite as spectacular as mid-September’s gain, but it was still impressive. There was good follow-through too, though the momentum softened as bulls knocked on resistance near $850.

The rally was a no-brainer. There is a strong line of support at $700, which was resistance during 2006 and the first half of 2007. Moreover, the market was, and is, oversold.

The catalyst was news that the U.S. government had to bail out Citigroup (NYSE:C), the world’s largest bank by revenues. The event has given way to new concerns about the economy, which weighed on stocks and gold this week, or at least provided an excuse to take some profits in the latter.

The big question now is whether it was just a retracement rally that ultimately gives way to new lows or whether we have seen the bottom in gold, with this rally being only the first of many to come.

I don’t think the chart can answer that question alone. Technically, the structure of the market is healthy now, and as far as the fundamentals go, gold should not remain under $1,000 for very long.

Indeed, I sense the market is building up for a very bullish move.

Allow me to touch on some of the bullish factors coming into play.

“Notwithstanding the many developments on the bailout front during the past six weeks, The New York Times, like other media outlets, continues to quote Wall Street insiders who report” [that] “‘You have a market that is frozen.’ What planet do these guys live on? It certainly is not the same one to which the Federal Reserve’s data apply. I’ve been singing this song for many weeks, but I’m going to keep singing it until somebody in the news media wakes up and realizes that these ‘frozen credit market’ tales are pure hooey. Look at the data, for crissake.”

- Robert Higgs, author of Crisis and Leviathan, in a recent essay on the bailout programs

The fundamentals are significantly bullish for gold. I’d like to say they are bearish for the dollar, but in truth, they are increasingly bearish for all paper currencies. Outside of the Bank of Japan, everyone is inflating madly. In the G-7, narrow money (M1) is growing at 7-10% on a year-over-year basis in the U.S., Canada, the U.K. and Australia – more in developing countries like China. And this rate is picking up now.

October’s data are not in yet for the ECB. Its balance sheet increased by some 400 billion euros during the month, which is the first big change since the second quarter, and will probably reflect in M1. The Bank of Japan started inflating M1 again in September too, after holding it steady for most of the year.

The broader monetary aggregates (i.e., those determined by the banking system at large) are growing briskly everywhere but in the U.S. and Japan, though even the latter are still growing.

Broad money in the U.S. is growing between 5-10%, depending on whether you rely on TMS or MZM or higher, if you like M3 (I don’t).

The U.S. data are good through October. Up till the end of September, as far as we are updated, the year-over-year growth rate in broad money approached 20% in Australia, its highest rate in almost 20 years. In the U.K., the broader monetary aggregates are growing at close to 14% on a year-over-year basis, which is its highest growth in almost a decade.

These growth rates are almost as bad as China’s, which is approaching 20% year over year too, again. Given these numbers, it is no surprise to me whatsoever that the yen is the strongest currency, followed by the U.S. dollar, or that the Aussie and the pound are taking the greatest beatings, along with all the other riskier currencies.

The actions governments are taking now are bearish for stocks and bullish for inflation. But they are not just bullish for inflation – they are remarkably bullish.

I don’t mean to sound happy about it. It’s just an observation that the market has yet to come to terms with. Since September, the Fed has expanded its balance sheet a total of $1.3 trillion. Of that total, it has created about $600 billion in reserves out of thin air.

Most of that is not counted in money supply, because it excludes deposits held by depository institutions. Total money supply is about $6 trillion, if you rely on the Austrian School definition (I do). It has, nevertheless, translated into growth of about $100-200 billion in new money created by the banking system since September already. Deflation is a no-show so far, and I don’t think it will arrive at all. I think history will see this as just another scare.

The Federal Reserve just announced two new programs that commit it to another $800 billion, and that is even before President-elect Obama puts his stimulus package together.

Reuters cited  Wachovia’s (NYSE:WB) chief economist:

“Some, however, are worried the mounting costs of the measures, which have the potential to reach several trillion dollars, could eventually fuel a troubling inflation.

“‘It may mean (a) longer-run issue with inflation and inflation concerns,’ said John Silvia, chief economist at Wachovia Securities in Charlotte, N.C. ‘It may be too much of a good thing is a bad thing.’”

Ya think?

Even more inflationary, in my opinion, is the fact that the talking heads think the Fed’s latest facilities are simply not enough. They are complaining the programs do not include direct purchases of credit card debt and mortgages in the secondary market and that the Fed isn’t going to buy mortgages with maturities of more than one year. Not long ago, the Fed never bought anything but Treasury notes.

Gold bulls are going to attempt to raid Comex’s vaults by forcing delivery on their December futures contracts (Dec. 19). Who can tell how that will go? I can’t. But it’ll be interesting to watch.

Facts: The open interest in futures contracts on the Comex has fallen to its lowest level since summer 2005, breaking a general uptrend in place since 2001. From a contrarian standpoint, the short-term bottoms in these data tend to favor the buyers over the sellers. However, the statistic went into orbit during the last half of 2007 – it broke away from the upper channel on the charts, creating a bubble in appearance. The current extremity could simply be a symmetrical reaction to that extreme.

Nevertheless, this is a bearish fact, technically speaking, if it represents a lasting new trend.

It is tempting to suggest that the threat of a raid in futures contracts is causing a short squeeze.

It is true that the commercials are liquidating their short positions promptly. But the funds are increasing their short bets, and the liquidation of longs is such that the net short ratio has hardly budged off its mid-September low – which, incidentally, is a level that has coincided with strategic buying points at seven other junctures since the bull cycle began in 2001.

However, the record of this statistic in gold is unique in that during bear markets, the commercials tend to be net long (wrong) most of the time.

So the fact that they are covering their short interests on net does not necessarily presage a rally if a bear market has set in. A bear market would mean that gold prices could fall as far back as US$500.

Fundamentally, the conditions just don’t look ripe for a bear.

I don’t believe the COTs (Commitment of Traders report published by CFTC) have any real predictive value. They tell us only whether the market is too much extended one way or another; they don’t tell us how long those conditions will last. Right now, the structure of the market is healthy. The commercials are covering their shorts, the funds are getting short and the numbers basically favor the bulls. The contraction in open interest worries me a little, but it could be explained in terms of a collapse in spread trades linked to various index products.

In its most recent report on gold demand, the World Gold Council said as much in trying to explain the drop in the gold price in the context of soaring physical demand. In its third-quarter report on gold demand, the WGC noted growth in both jewelry and investment demand across the spectrum relative to both the last quarter and the year-ago quarter. I don’t want to go into a critique of the method here, except to point out that it chronically understates investment demand and overstates jewelry demand.

The inclusion of ETFs all but proves the point.

In just one year, investment demand has grown in importance from under 15% to over 30% of total gold demand, causing the deficit (supply shortfall) to grow nearly tenfold. The WGC interprets this deficit as supply coming from speculative sources, like futures trading or changes in inventories at the various exchanges – like at Comex. Thus, it calls it “inferred investment.” Formerly, it called this the “balance.” But as it grew, the WGC decided it meant something. What is causing it to grow, aside from growing demand in general, is that while the WGC is “identifying” new kinds of demand, it has not kept up with the various sources of supply. Gold bugs have argued for years that the supply of gold is not limited to mine production, officialdom or scrap…that it is not like other consumable commodities.

It is more useful to assume that most of the gold ever produced is held as a reserve, or store, aboveground. And if this is true, then investment demand must be much larger than the WGC calculates, or the price would, frankly, never go up. If the WGC is smart enough to include producer hedging (or dehedging) in the equation, it should also include a measure of demand that expresses itself through all the exchanges and bring itself up to speed on all the sources that supply the market. It assumes that jewelry demand dominates the market, which is incorrect, but even if it were, it still has the wrong idea.

Jewelry demand may be price sensitive in the short term, yet it has grown every year, at successively higher prices, since the bull market began. Despite my objections, however, I am in total agreement with the council’s explanation why gold prices have fallen despite the evidence of soaring gold demand:

“Notably, the selling captured by the [inferred] investment category was mainly by investors with a short-term focus. It largely reflects the fact that gold was caught in the downdraft of other commodities and other assets – it does not reflect a questioning of gold’s value or role as a safe haven. The strong buying in the ETF and bar and coin markets during the quarter, which reflects investors with largely a longer-term focus, suggests that investor belief in gold’s role as a safe haven and store of value is stronger than ever.”

No wonder the commercials are covering. The establishment is getting hot for gold.

JP Morgan’s gold analysts “urged” investors to stock up on gold this month, citing counterparty risk and tight supplies.

Citigroup’s foreign exchange group also put out a bullish tout.

Well, that’s an understatement, actually. “[Gold] continues to look like a bull market to us. We continue to believe that a move of similar percentage to that seen in the 1976-1980 bull market can be seen, which would suggest a price north of $2,000,” Citigroup’s FX group said last week.

What I found particularly intriguing, besides the timing of these calls, was that they both discounted the dollar. That is, they noted, as I have in the past, that the foreign exchange value of the dollar may not be important at this stage. Morgan said, “It is not an absolute given that a rally in gold means a falling U.S. dollar,” while Citigroup pointed out, as I also have, examples of just such a situation during the 1970s.

Anyway, it’s not a sure thing yet, and it all makes great fodder for the bull market in gold.

Source: Gold Looks Bullish as Dust Settles

Oil prices steadied on Friday, after falling more than 7 percent the day before, as stock markets recovered from early lows caused by continuing economic gloom.

U.S. crude fell 13 cents to $49.29 a barrel at 12:08 p.m. EST (1708 GMT), after earlier hitting $48.25, its lowest level in three and a half years. London Brent crude gained 53 cents to $48.61 a barrel.

U.S. stocks recovered slightly after falling into negative territory on Friday as shares of financials, including Citigroup , declined and investors worried about the deepening economic slump.

Slumping demand in the United States and other top oil consuming nations has sent crude prices plunging from record highs above $147 a barrel in mid-July.

On Thursday, oil fell more than 7 percent on gloomy economic data, to settle at its lowest since May 2005.

“Obviously, we are reluctant to call a bottom to this dramatic price decline that is now approaching 4-1/2 months. The attachment between the oil and stock markets will likely remain valid, at least through month’s end,” said Jim Ritterbusch, president of Ritterbusch & Associates in Galena, Illinois.

JP Morgan said on Friday it expected world oil demand in 2009 to decline by 500,000 barrels per day as the global credit crunch continues to rack the world economy.

Members of the Organization of the Petroleum Exporting Countries will meet in Cairo next week, but may not take any decision to reduce output to defend prices.

“In Cairo we will not have the complete data about the market,” OPEC President Chakib Khelil said. “It’s very possible that we will not take a decision until we will see the impact. This impact will not likely be seen until December.”

OPEC will meet on Dec. 17 in Oran, Algeria.

Industry consultant Petrologistics estimated OPEC oil production will fall by 1.22 million barrels per day in November.

OPEC agreed in October to cut output by 1.5 million barrels per day from Nov. 1, but the move has failed to stem the decline in oil prices.

According to the ad, the latest campaign, published in Monday’s Wall Street Journal, celebrates the institutions’ long-term safety net of public funds up to US$100,000.